1. Field of the Invention
The present invention relates generally to the field of collateral matching and mark to market reconcilement that allows parties to a financial transaction to easily, efficiently, and reliably manage the margining process. More particularly, the present invention provides secure, high-volume processing methods and systems for multiple financial instruments that combine collateral matching to identify matched and unmatched financial transactions and consolidated mark to market valuations for all parties to a matched financial transaction.
2. Background
Financial market participants are constantly aware of the risks and opportunities in the dynamics of the foreign exchange, derivatives market, and securities market. Bilateral margin agreements are dynamic market contracts in which the parties must account for the margin, the variance in value between the contract price and the market price. Subject to market fluctuations, the valuation of the margin by each party is often a source of conflict and tremendous market inefficiency. Whether it is the complexity and volume of the transactions between the parties, the use of different formulae to calculate the value of the transactions, or a combination of the above factors, the disconnect in margin valuation demands a time consuming manual review process that is detail-oriented and error prone. Manually reviewing a difference or discrepancy in the margin valuation keeps the parties from adequately and promptly assessing its business risks and opportunities in a rapidly changing market economy.
Bilateral margin agreements require each party to bear a high level of risk in dealing with the other. The variance of the market and its effect on the margin valuation can create various incentives for a party to take advantage of a favorable market or to remain inactive. The risk is in the party's mark to market valuation of the margin and in the varying market valuation of collateral agreements. Derivative instruments, such as, an interest rate swap, a currency swap, or an interest rate option, pose the greatest risk valuations because they are based on changes in terms of notional amounts and not on exact values.
Typically, a major party, A, such as any major global financial institution or bank, has a significant book (portfolio) of transactions. For example, a particular global bank may have anywhere from one to fifty (50) transactions against a counter-party, B. Those transactions might be booked and they might all be confirmed, but they are for different notional values, different periods of time, and, in fact, some of them may be interest rate swaps and some of them may be currency swaps. Such a portfolio of transactions raises a significant number of risk issues.
One of the risk issues, for example, is the mark to market value of a particular transaction. For example, the interest rate swap transaction that lasts over an eighteen (18) month period has an initial value at financial transaction date. However, because time passes and there is a timed value of money, the value of that transaction changes every day. It changes based on how interest rates change, which is the floating side; it changes based on exactly how time passes; and it also changes based on factors involved with the volatility of interest rates.
The changes can be calculated using, for example, complicated mathematical formulae, but the important factor is that the value of the transaction between A and B is different every day. In a portfolio of transactions, let us say fifty (50) transactions, for different values between A and B, some of these transactions can be in the money and some of them can be out of the money to either party. Generally, these values are netted because the parties have netting agreements established between them. However, the problem remains that it is most likely that one party is going to be net out of the money with the other party.
Assume, for example, that we have fifty (50) transactions in this portfolio between A and B, and that B is $2 million out of the money as of a given day, such as today. This means that A has at least $2 million of pure, economic risk that if B, for example, becomes bankrupt today, A will not receive these moneys. Therefore, the institution of collateral agreements has become commonplace within the marketplace.
A collateral agreement means that, based on certain parameters, if B is out of the money, such as $2 million, B will post an agreed upon amount of collateral to be held by A until the market changes. The market changes every day, and rather than going through the laborious and inefficient process of margin-call, B sends A collateral, a smaller sum of money, such as, $50,000.00. In other words, until the market changes $50,000.00 back in B's favor, A would keep the collateral. Collateral agreements make sense in continuing business relationships because the changing market conditions make it unreasonable to constantly move money between parties when one party's gains on one day may be losses on the next.
Given the improved efficiencies of collateral agreements over margin-calls, there are still inefficiencies in their use. For example, the amount of collateral must be agreed upon and must be delivered to the proper party. Additionally, the timely movement of collateral between parties can be a source of inefficiency if the parties are unable to agree upon the amount constituting collateral. Further, the difference in how parties mark to market the collateral becomes a critical issue.
Collateral, such as, a government bond is marked to market daily because like any other financial instrument, the value of that bond changes every day. Mark to market is a representation of the daily market value and the changes to those market values over a period of time. When any A has multiple collateral agreements with multiple parties, the portfolio of transactions typically includes a variety of different types of transactions, such as, foreign exchange forwards, interest rate swaps, and currency swaps. Accordingly, there is a myriad of bilateral margin agreements in place.
The current process of reconciling these types of financial transactions is manually intensive, extremely time consuming, and tedious. For example, when A and B have 500 transactions, it can take up to six months just to reconcile those transactions, because transactions are maturing and new transactions are entered into. Some of the transactions may be rather complex and may be under limited control in manual spreadsheets. When these transactions are handled on a manual basis, the mark to market updates can be made on an irregular and unsynchronized schedule, thus causing a disparity in the margin valuation and inefficiency incurred through the review process. At a high level of volume, the process becomes untenable, inefficient, and error prone.
The ability to reconcile a specific transaction that A is valuing and that B is also valuing is further affected by the likelihood that the two parties are not using exactly the same formulae for creating the value of that transaction. Without an established or agreed upon standard of formulae for calculating the margin, there will always be differences of opinion between A and B, although hopefully minor, as to what the value of a particular transaction is on any given day. Therefore, in addition to agreeing between parties A and B that these transactions exist and that the components of the transactions are equal, it is also necessary to mark to market the value of a particular transaction from both sides on a given day's basis and to reach an agreement on the net value of all transactions.
Thus, a need exists for a methods and systems for remotely accessing a secure communications network that provides parties a single point of entry to electronically process collateral matching and mark to market valuations of multiple financial instruments in numerous financial transaction. A need also exists for collateral matching and mark to market methods and systems that afford basic checks on financial transaction data and that prevents duplicate submission of this data. There is a further need for flexible collateral matching and mark to market methods and systems that are able to: (1) provide real-time identification of matched and unmatched financial transactions; (2) provide real-time mark to market portfolio valuations; (3) provide standard formulae and user preferences to develop algorithms for real-time mark to market portfolio valuations; (4) minimize manual review of discrepancies in margin valuations; (5) accommodate additional financial instruments and additional users as the system expands; (6) facilitate lower financial transaction and processing costs; (7) provide multilingual capabilities, settlement currencies, and other identifiers necessary to globally communicate with users interested in collateral matching and mark to market portfolio valuations; and (8) minimize the manual entry and re-keying of information into multiple formats and templates used by parties to a financial transaction.